Is Franco-Nevada About to Repeat Freeport-McMoRan's Mistake?

Franco-Nevada (NYSE: FNV) has made a name for itself by focusing on streaming deals with precious metals miners, and the company has successfully built up a lucrative portfolio that is highly concentrated on gold streaming deals. Yet in search of new avenues for growth, Franco-Nevada recently said it sees gold as being largely played out, and it wants to look elsewhere for better opportunities. Before it does so, though, Franco-Nevada should look closely at how Freeport-McMoRan (NYSE: FCX) fared in making a similar ill-fated decision.

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What Franco-Nevada wants to do

Franco-Nevada CEO David Harquail recently spoke at the BMO Capital Markets mining conference. The industry conference provides a forum for miners and related companies to discuss their strategic plans, and Harquail revealed that he believes that there's no growth left in the gold mining projects in which miners are now investing capital. The CEO's argument is that if the new projects in which mining companies are focusing their attention right now had been truly lucrative, they would have been developed long before now.

Instead, Harquail wants to pull Franco-Nevada more toward the oil and gas sector by accumulating royalty interests. The company already has the right to do so, with an investment philosophy that lets it have up to 20% in agreements that don't encompass precious metals. Even though the CEO believes that the streaming deals Franco-Nevada has with mining companies will produce ample streams of precious metals to provide cash flow, further growth in the sector will be difficult. Energy, on the other hand, has a large number of prospective opportunities in Harquail's eyes, and he believes that Franco-Nevada can negotiate lucrative royalty deals that could produce substantial growth both from production increases and a potential rebound in crude oil in the years to come.

Franco-Nevada has royalty and working interests in several assets in Western Canada and the Arctic. Image source: Franco-Nevada.

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Can Franco-Nevada succeed where Freeport-McMoRan failed?

What Harquail is saying bears an uncanny resemblance to similar comments that executives at Freeport-McMoRan made when they chose a similar strategic decision for the copper and gold mining giant. In late 2012, Freeport decided to buy McMoRan Exploration and Plains Exploration in a $20 billion acquisition. At the time, CEO Richard Adkerson said that the deal would create "a larger, more diverse company with an enhanced exposure to the global growth story and improved growth characteristics for our company."

Also, Adkerson argued that the move would take pressure off the company to produce immediate growth opportunities in the copper and gold space. "Our copper investments are limited," he said, "by the timeframe that it's required to take resources and put them in the development stage and bring them to cash flow projects. External growth opportunities are limited."

In the end, Freeport's deal proved to be terribly ill-timed. Plunging crude prices in late 2014 and 2015 caused Freeport to take multibillion-dollar impairments related to the oil and gas acquisitions, and even after recent gains, the resources giant's stock is still down by about two-thirds from its 2014 levels before oil's bear market began.

Will Franco-Nevada get itself in trouble?

Franco-Nevada has already started executing on its strategic diversification plan. In November, the company invested $100 million to buy royalty rights related to the STACK shale play in the Anadarko basin in Oklahoma. Although cash flow from the acreage was just $3 million per year in late 2016, full-field development is expected to start this year, and that should boost royalty cash flows dramatically.

One reason investors shouldn't be as worried about Franco-Nevada's approach is that it is disciplined and comes at a better time than Freeport's deal several years ago. Despite the rebound in oil, the energy market is still well below its highest levels, and many see further opportunities for recovery in the near future.

Perhaps more importantly, Franco-Nevada's downside is limited to the amount it invests in the deals. Although a potential drop in oil prices could reduce cash flows, Franco-Nevada is unlikely to see its cash flow dry up entirely. By being disciplined about the partners it chooses and the terms it sets, Franco-Nevada can avoid the mistakes that Freeport-McMoRan made.

Gold investors might not be happy about Franco-Nevada's decision to move away from its near pure-play status in precious metals streaming. But if the company's executive team is correct, moving more toward energy to become a diversified commodity-interest financier could bring faster growth than remaining solely focused on gold and other precious metals.

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